Similarly, the Fed may decrease the money supply by raising reserve requirements.

16Discount Rate (Primary Credit Rate)

The discount rate is the rate of interest a Fed District Bank charges when a bank borrows from it.

When the Fed raises the discount rate, it raises the cost of borrowing reserves, reducing the amount of reserves borrowed.

Lower levels of reserves result in reduced lending, and reduced money supply.

17Open Market Operations

Open Market Operations (OMOs) buying and selling of government bonds by the Fed to control bank reserves, the fed funds rate, and the money supply.

Buy Ease Sell Tighten

An increase in reserves results in an increase in the money supply and a reduction in the fed funds rate.

18Now to combine money supply with money demand

Transactions demand hold money to buy goods and services.

Precautionary demand cover unplanned transactions or emergencies.

Speculative demand deal with uncertainty about the value of other assets

fear decline in the value of other assets, so hold money as a safeguard.

19Money DemandInterest rate is opportunity cost of holding money. The higher the interest rate the lower the quantity of money demanded. 20Effect of a change in income on money demandTransactions demand increases with income. As nominal income increases, the volume of transactions increase, requiring more money. 21Money SupplyMoney supply is controlled by the Fed, and therefore is not a function of interest rates. As a result the money supply function is vertical. 22Money Market Equilibrium 23How Money Supply Changes affect GDP 24Money Supply and Interest RatesM2M1Fed Increases Money SupplyInterest Ratesr1Interest Rates Fallr2MdMoney